高樂氏 (CLX) 2007 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the Clorox Company fiscal year 2007 first-quarter earnings release conference call. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, we will conduct a question and answer session. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded. I would now like to introduce your host for today's conference Mr. Steve Austenfeld, Vice President of Investor Relations for the Clorox Company. Mr. Austenfeld, you may begin.

Thank you. Welcome everyone and thank you for joining Clorox's first-quarter conference call. I'm Steve Austenfeld, Clorox's Vice President of Investor Relations. We're very pleased with us today to have Don Knauss, our new Chairman and CEO, on the call with us. Also with us are Larry Peiros, Group Vice President of our Household Group, and Dan Heinrich, our Chief Financial Officer.

We're broadcasting this call over the Internet and a replay of the call will be available for seven days at our web site, thecloroxcompany.com.

On today's call, Don will start with some comments on the Company's first quarter results as well as his first month with Clorox since becoming Chairman and CEO. Larry will then provide some business observations about the quarter, including perspective on the near-term costs, pricing and competitive environment. Dan will then review our financial performance for the first quarter, followed by additional detail supporting our fiscal year 2007 outlook as communicated in our press release this morning. Finally, Don will wrap it up and then we will open it up for your questions.

Let me remind you that on today's call, we will refer to certain non-GAAP financial measures, including but not limited to adjusted operating profit and free cash flow. Management believes that by providing [endplates] on these measures, we enable investors to better understand and analyze our ongoing results of operations. Reconciliation with the most directly comparable financial measures determined in accordance with GAAP can be found in today's press release, this web cast, prepared remarks or supplemental information available in the financial information and results area within the investor section of our web site, as well as in our filings with the SEC.

Lastly, let me remind you that today's discussion contain forward-looking statements. Actual results could differ materially from management's expectations. Please review our most recent 10-K filing with the SEC and our SEC filings for a description of important factors that could cause results to differ materially from management's expectations. With that, let me turn it over to Don.

Thank you, Steve, and hello everyone and I would like to add my thank you for joining us. We're very pleased with our results for the quarter. Top line growth as you have seen was strong and we delivered the high end of our earnings outlook. The healthy 5% sales growth came from increases across all three segments, driven primarily by price increases taken in fiscal 2006. Now in particular, we feel good about our Q1 results in Homecare behind volume gains for Clorox Disinfecting Wipes building on our health and wellness platform, some strong shipments of cat litter as consumers continue to respond well to our new product with activated carbon, as well as healthy volume gains in Latin America behind recent new product introductions and category growth.

Now before Dan and Larry come on to discuss the Company's first quarter results and outlook for the balance of the year in detail, I would like to take a few minutes to introduce myself to those of you whom I don't know, and specifically I would like to highlight why I came to Clorox and then talk about my plans for the first 100 days here.

Since the announcement of my appointment, one of the questions I have certainly been asked frequently is -- why Clorox? And as some of you know, I began my career as a brand manager for Procter & Gamble. I then spent in age 22 years in the food and beverage sector of the consumer products industry, most recently with the Coca-Cola Company. Now throughout that time, I had the opportunity obviously to observe Clorox and Clorox people, and I certainly admired what this company has achieved and what it stands. So for me, the reasons for joining Clorox are very clear and there are three that I would like to highlight for you.

First, Clorox has great brands and the Clorox portfolio includes some of the consumers' most trusted brands and its mission to build brands and make consumers' lives easier, healthy, and better is certainly compelling for me. And in fact, the Company has about 12 number-one brands in their category. So the Company has a deep consumer focus, a track record of success in linking insights into what consumers really want and continually innovating to bring those high-quality products to market. And I really do believe that this strategy of building big share brands in mid-size categories in an advantaged position to be in.

Clorox also has strong partnerships with its retail customers. It certainly understands their needs and works with them to deliver value-added services that help deliver consumer value. Clorox has been growing well. It remains keenly focused on growth which certainly makes it an especially exciting time for me to be here.

Now one of the reasons I have confidence in Clorox's future is how well the Company's brand and strategies align with three important global consumer trends that we are seeing. The first is health and wellness, second convenience, and third sustainability. I think in particular, Clorox teams have really done an excellent job broadening our brands across the health and wellness platform. And also understanding consumers' desires for convenience has certainly been a key to success of brands like Clorox Toilet Wand. I think Brita is a great example of a brand that we can leverage to meet consumers' increasing demand for products that deliver sustainability. We will need to continue that work and deepen our understanding of how our brands can play across all three of those global trends.

Second, Clorox has great people. As I noted earlier, I've observed folks from this company for years, but it's known for its smart and talented people, and my experience as I said bears that out, especially as I've been getting to know folks during these first few weeks. Last week, someone asked me what surprised me most about Clorox, and I really think it's the passion of the people that this Company has for its brands. Coming from such an iconic brand as Coca-Cola, I didn't think many other companies would have such a high level of passion for the brand, but I can tell you the folks at Clorox do. And I'm certainly inspired and excited by this team. I'm especially delighted to be working with such a strong executive team here and I want to assure you that I'm committed to working with this team to drive the future growth of the Company.

I think the third reason is just the culture of Clorox. It's a culture based on deeply-held values that are certainly consistent with my own, and that starts with integrity which is paramount to me and to our executive team and all of the folks at Clorox. And over the years, I've heard from countless customers about the integrity of Clorox people and the Company's policies and practices in dealing with employees and retailers, vendors, suppliers and the community, and I've been impressed with the Company's commitment to community involvement, which is something I will certainly hope to help foster in the years ahead.

Now I would describe these first three months as a look listen and learn period for me. I really want to hear what employees and consumers, suppliers and investors think and feel about this company. I've been walking the halls of the Bay Area offices as well as traveling to field and international locations to talk with employees. I have already met with three of the Company's top six customers and the Clorox team supporting them. I've also been up to see the Canadian operation and I have plans to connect with more in the weeks ahead. Now in the near future, I expect to be on the road to begin meeting with some of you folks and investors as well.

I'm also engaged with the leadership of the Company to refresh our strategic agenda starting with real clarity on what we define as our true north, if you will, for the Company. What is the single measure of success from a shareholder perspective, as well as how we'll determine our success five years plus from now. I would describe it as Clorox's Centennial destination -- what we'll look like when this Company reaches 100 years of age in 2013. Now this work is going to build off the what I would describe as a very successful strategy that is currently in place. We have set a date of May 24 for our next analyst meeting, which will be held in New York, and that will give me time to be fully immersed in Clorox and provide sufficient time for the strategy refresh process to be completed. And the leadership team and I look forward to sharing that updated strategy with you then.

Closer in of course, I'm focused along with the entire organization on the Company's success in FY '07.

So just to summarize this introductory part, I really like the position Clorox is in. We have a strong financial foundation. I think we have a tremendous executive and leadership team here and a solid strategic plan that's delivering real results over a sustained period of time. And it's truly an honor for me to be here and to be part of this Company and this team and I look forward to meeting many of you over the coming weeks and months.

Now what I would like to is turn it over to Larry and he will give us all an overview of the first quarter performance. Larry?

Thanks, Don, good morning. As Don said, we're very pleased with our results in the first quarter. Sales were up 5% with sales gains in each of our three business segments. [Line] declined 1% due to price increases taken earlier in the calendar year and competitive activity in certain categories. Q1 gross margin was up about 70 basis points. Our outlook anticipated a gross margin gain in fiscal '07 with most of the gain coming in the second half. This Q1 gross margin improvement was a bit better than forecasted.

Our advertising investment was about 10% of sales, an investment level that we have sustained over the last couple of years despite the intense commodity cost pressures. Our innovation program continues to pay dividends with the last two most recent core growth launches -- cat litter with activated carbon and Clorox Ultimate Care Bleach -- off to a strong start. Finally, our diluted earnings per share was $0.73, at the high-end of our outlook range.

Dan will be reviewing our financial results in detail, but before he does, I wanted to provide some overall perspective on the business in three areas -- first, the health of our brands, next some emerging competitive issues, and finally commodities.

Let me start with the health of our brands. As we have said many times, we stay true to our strategy and growing our brand despite the commodity cost environment. We're very proud of what we've been able to accomplish in a very tough cost situation. We are applying new and better consumer insights across all of our businesses. We've maintained our advertising investment at strong levels. We grew our R&D investment, continuing to improve existing products and launching new ones. Our new Kingsford Surefire Briquette is meeting objective and helping us to grow share in charcoal. Our Fresh Step Cat Litter with Activated Carbon drove a 5% shipping gain on our overall cat litter business during the quarter. Finally, our new Clorox Ultimate Care Premium Bleach is meeting initial trial objectives and attributed to more than a 2-point share gain for our total bleach brand. In fact, our shares are up in four of eight tracked categories in the U.S.

On the opportunity side, our volume remains flat to slightly down. The flat volume is mostly driven by our pricing actions over the last year. These volume results remain consistent with what our pricing models predicted, and all in all we feel good about the health of our brands and the tough choices we have made over the last year.

Next, I want to talk about some emerging competitive issues. We are seeing a very large step up in competitive spending in some categories. It appears that the recent and projected softening of raw material prices has led some competitors to greatly increase promotional and marketing activity. In particular, there is aggressive competitive spending in trash bags, a category where we have grown substantial share in the last two years behind our ForceFlex launch, despite a couple of very significant price increases. As you have heard us say many times before, we take price increases based on our view of the long-term cost structure of our products, including commodities. We continue to believe that with many commodity prices nearly double their historical averages, our pricing is about right. At this point in time, we plan to hold pricing across the portfolio. The one category we will closely monitor is the trash bag business. We will defend our business, even if it means some margin and profit downturn in the near-term. First and foremost, we're committed to maintaining the long-term health of our brands.

Now let me speak more specifically to commodities. Commodity costs did have a material dilutive impact on margins in Q1 and commodity prices continued to be unpredictable. Though we anticipate that commodity prices will moderate during the course of the year, commodity prices remain at a very high level and play out somewhat differently across individual business units. In fact, we're executing some additional select price increases in fiscal '07, including a price increase on Kingsford Charcoal, where commodity cost and transportation expenses are still increasing. We continue to aggressively pursue cost savings, including more effective raw material sourcing. Generally speaking, our commodity costs lag the market on both the downside and upside because of hedging, contractual arrangements, inventory positions and other measures we put in place to help control and stabilize cost.

To conclude, we're very pleased with our operating results in the first quarter and proud of the results we have delivered over the last year, despite the intense cost environment. Looking forward, we still have some volatility on the commodity front as well as some competitive issues, but we are confident that we can successfully address these challenges. Our outlook includes our latest view of the commodity cost environment, the impact of our brand-building and innovation efforts, as well as the impact of measures we will take to defend our business where competitive activity has accelerated. With that, I will now turn it over to Dan for more details.

Thanks, Larry. With that overview from Larry, let me walk you through our financial results in more detail. At $0.73 per diluted share, we came in at the high end of our EPS outlook range of the quarter primarily due to increased sales and improved gross margin results. We're particularly pleased with these results in line of ongoing commodity cost pressure and the impact price increases have had on our volume.

On the top line, first quarter sales increased 5% compared with the year-ago period. Sales came in at the high end of our outlook range, driven by price increases, trade promotion spending efficiencies, volume growth in Homecare, Cat Litter and Food and increased shipments in our international business on top of 14% volume growth in the year-ago period. Laundry, Auto, Brita and Glad volumes declined, driven by the impact of price increases as anticipated, as well as some competitive activity in certain businesses. As Larry noted, the Glad business has been impacted by significant competitive activity in the trash bags category. Charcoal volume declined versus the prior-year quarter due to lower conception resulting from poor weather over the Labor Day weekend, especially on the East Coast. That said, we're very pleased our charcoal shares continued to grow behind our launch of Kingsford Charcoal with Surefire Grooves.

Gross margin for the quarter was 42.9% compared with 42.2% in the year-ago quarter. We feel especially good about this result, given the challenging commodities cost environment we're in. Let me break down the 70-basis-point increase for you. Commodity costs impacted us by negative 280 basis points in the quarter, which is down from the negative 360 basis point impact in the year-ago period and down from the impact in the fourth quarter. Commodity cost increases were more than offset by 210 basis points of net gross margin improvement from price increases and about 190 basis points from our cut costs and enhance margin strategy. All other factors affecting margins represented about 50 basis points of dilution.

As a reminder, we will not anniversary the full impact of the post-hurricane commodity cost increases until our fiscal third quarter.

Now in line with gross margin, adjusted operating margin increased to 17.4% for the quarter, compared with 16.8% in the year-ago period. The 60 basis point increase is about equal to the change in gross margin as advertising and cumulative SG&A expenses were about the same year-over-year on a percent of sales basis. First quarter SG&A also included about $3 million in pretax costs associated with the IT services agreement.

Our effective tax rate for the quarter was 35.9% versus 30.2% in the year-ago quarter. Now our Q1 tax rate is slightly higher than our anticipated full-year tax rate, which we expect to be in the range of about 35%. The lower rate in the prior year was driven primarily by releases of federal and state tax accruals due to some favorable tax settlements. As we have said, our tax rate will vary by quarter and we anticipate our second and third quarter effective tax rates will range around 35 to 36%.

Turning to cash flow. First-quarter cash flow from operations was about $133 million compared with a decline of $59 million in the year-ago quarter. The increase was primarily due to last year’s $151 million income tax settlement payment. Free cash flow, which we define as cash flow from operations less capital expenditures, was about $102 million, or about 9% of sales. Our strong free cash flow was due to solid earnings, continuing disciplined capital spending and effective working capital management. A portion of this free cash flow was used to reduce debt levels.

Now I will move onto our outlook for Q2, Q3 and the full fiscal year. Before I discuss our fiscal year 2007 financial outlook, I want to comment on a number of trends you should consider in assessing our outlook. Our current outlook continues to reflect our best estimate of the impact commodities cost will have on our results over the balance of the fiscal year. We will not fully anniversary the peak commodity cost levels following hurricanes Katrina and Rita until our fiscal third quarter. We are starting to see some softening on commodities prices and expect to see some further softening as we move into the second half of the fiscal year. Commodity prices continue to be very volatile and difficult to estimate with precision, and it is possible that commodity costs could soften more than what we have included in our outlook. If there is any material incremental benefit in fiscal '07, we will consider reinvesting that benefit in selected categories to maintain the long-term health of the business.

As Larry noted, we're seeing increased competitive activity in the trash bag category. We intend to defend this important business and our outlook includes some incremental spending to respond to the competitive issues. We'll do what is necessary to defend our businesses, even if that impacts on margin and profits beyond what we've factored into our outlook. We're very committed to maintaining the long-term health of our brands.

We continue to benefit from the various pricing actions taken in fiscal year 2006. We will fully anniversary the bulk of the price increases in our fiscal third quarter. The shorter-term volume impact from our pricing actions has been generally consistent with our pricing models and we continue to anticipate a return to volume growth in the second half of the fiscal year.

As we recently announced, we entered into an IT services agreement with a third party. Our outlook previously reflected an estimated $12 to $15 million in pretax transition and restructuring costs. The final IT services agreement includes a broader range of services than originally assumed, which will lead to greater cost savings when fully implemented. However, the total estimated fiscal year 2007 pretax transition and restructuring costs associated with the services agreement are now about $20 to $22 million with $3 million reflected in Q1 and about $8 to 9 million estimated for each of the second and third quarters.

In fiscal 2007, we anticipate core growth and innovation across a number of categories. As we have said, core growth innovation, defined as products that we anticipate, will add $10 to $30 million of incremental sales growth. It's very important as it keeps our brands healthy and competitive. While we don't anticipate that we will launch game change of product in fiscal 2007, we estimate that our core growth initiatives will deliver 1% to 2% percentage points of incremental top line growth which is in line with our annual target of growth from innovation.

We continue to believe that on average we will launch about one game changer a year and have been fortunate to have had a couple of recent years when we've launched more than one game changer product. We anticipate launching another game changer in fiscal year 2008.

Let me now cover our Q2, Q3 and full-year financial outlook. As you saw in this morning's press release, we confirmed our second-quarter and full-year outlook, which we last communicated in August, and we provided our initial outlook on the third quarter. Recent competitive activity in our planned responses, combined with higher FY '07 IT services agreement costs lead us to believe we'll likely be at the lower end of our EPS ranges. For the second quarter, we continued to anticipate sales growth at the low end of our long-term 3 to 5% target range. This compares with a very strong 6% growth rate in the second quarter of the last fiscal year. This sales target range reflects the ongoing impact of price increases taken in fiscal '06 as consumers continue to adjusted to higher shelf prices. We continue to anticipate second-quarter earnings per diluted share in the range of $0.48 to $0.54. This includes about $0.03 to $0.04 per diluted share related to transition and restructuring costs associated with the IT services agreement.

In the second quarter, we expect continued modest gross margin improvement. Although the commodity cost environment is improving, keep in mind we're still comparing against a base period that had not seen the full effect of the commodity cost increases. We anticipate a second quarter decline in adjusted operating margin, primarily related to increased selling and administrative expense stemming from the IT restructuring activities, an increased investment in advertising to support the long-term health of our brands, partly in response to the competitive activity we are seeing as well as to continue support for new products. For the third quarter, we anticipate sales growth of 3 to 5%. We also anticipate third quarter volume and sales results to be more closely aligned as we lap the majority of the price increases from last fiscal year.

Now as Larry mention, we intend to take price increases on Kingsford products to recover some of the higher raw material costs. The price increases are effective January 1 and will be in the range of 4 to 8%.

Our initial outlook for third quarter diluted EPS is $0.74 to $0.80. Included in this outlook is a $0.03 to $0.04 impact of increased costs associated with the IT services agreement. We anticipate a third quarter effective tax rate of about 35 to 36%.

As I already mentioned, we're confirming our full-year outlook; that is, sales growth of 3 to 5% and diluted earnings per share in the range of $3.20 to $3.30. As a reminder, included our fiscal year outlook is about $0.05 per diluted share due to the second year of incremental costs related to the impact of equity compensation accounting under FAS 123(R). The fiscal year outlook also includes about $0.08 to $0.09 diluted EPS of ITSM costs. Due to the impact of higher costs associated with the IT services agreement, we anticipate being at the lower end of the $3.20 to $3.30 EPS outlook range.

Now with that, I will turn it back over to Don for wrap-up and Q&A.

Thanks, Dan. Let me just take a minute to reinforce a couple of key points Dam made regarding our outlook. We do anticipate that the commodity cost environment will remain volatile throughout fiscal '07 and fiscal '08, making it challenging to precisely predict how commodity will impact our plan. I want to reinforce the continuing theme with the executive leadership of this company. We make decisions based on the long-term health and profitability of the business and we continue to focus on consistently delivering against our annual goals. While the quarters may have some variability, our focus is on a consistent annual performance and the long-term health of the business.

Now before I open it up to your questions, let me just recap what I hope you will take away from today's call. First, we are pleased with the Q1 results. We drove sales growth in all three segments, we saw gross margins and increase and adjusted margin improved and we continue to invest in advertising and innovation. Second, the commodity picture is improving, but commodities are still at a high level and volatile and our best projection of how commodity cost will play out in our businesses is reflected in our outlook. And third, we are also committed to supporting our businesses in situations where competitors have stepped up their spending. And finally looking ahead, while we face some challenges, we're committed to success in fiscal '07.

So with that, I would ask the operator to open it up for your questions.

(OPERATOR INSTRUCTIONS). Chris Ferrera, Merrill Lynch.

I just wanted to ask about the bags and wraps competition you're seeing. Is that from your branded competitor impacted alone, or are you seeing private-label pressure as well in the business?

Let me step back for a minute on Glad because we have obviously had some terrific performance on this business. We established this really unique JV with Procter, did well with Press N' Seal, that was the first innovation out of that relationship, have done well on our GladWare business, and we've done particularly well with ForceFlex, getting about 5 share points over the last two years. Had a lot of pricing in the category. We ourselves took three price increases on our trash business. We are seeing some price declines both on private labels in terms some of the of actual price sometimes just promoted or trade spending, merchandising pricing, as well as from Hefty. And they're either [spending] back some short-term savings or there are anticipated savings on the resin front.

So you think you're seeing -- you're not seeing list prices come down necessarily, and I guess that means that you had reacted much the same way, given that you said that you want to hold your pricing at this point?

We have seen some limited list price pricing activity -- or let me say that again. We have seen some limited declines on private labels in terms of list prices, and most of the other activity has been promotional or trade spending to drive merchandising activity versus list pricing declines.

Got it. And have you seen heightened competition in any other categories, besides bags and wraps?

There has been a few categories. Homecare is always a category where there's an awful lot of competitive activity, but there are some definitely -- there's some heavy-duty spending in disinfecting wipes. Again, this is a category where we've had a lot of success. Our wipes business has grown at a 20% compound annual growth rate over the last five years. And in particular, there's that one key competitor that would like to have a bigger share of that category, and we have seen some pretty intense spending there. Seen a bit of an increase in lower price brands in the color-safe bleach category, which has had some impact, and we have seen a fairly successful launch by one of our competitors in the Bathroom category. Those would be the highlights of the competitive situation.

I'm sorry, just one follow up to that. Those other three - the wipes, color-safe bleach and a launch in home -- it's hard to tell. Do you think those are resin-related and commodity related, or do those seem to have other strategies at heart?

Probably a combination. I think in the case of wipes, you have a competitive that has basically been at a disadvantage from a share standpoint for a longtime, and maybe using cost savings in that line or other lines to support some increased trade spending activity. That may not necessarily be tied specifically to a pricing action or some commodity cost decline.

Thank you very much.

Bill Pecoriello, Morgan Stanley.

Good afternoon, everyone, and congratulations again to Don. A question on gross margin. Looking out to the second quarter, do you see the components that you laid out in Q1 -- commodity impact, pricing and savings -- being similar in the second quarter? And you were referring to some of the lags on lower oil prices. In resins, did some of the price increases that were announced last quarter go through, or are you starting to see an indication of it coming down.

Bill, let me first address what we anticipate we'll see in the second quarter. We are still looking for some honest gross margin improvement in the second quarter, and it's the same factors that will drive it. We're certainly going to continue to see the benefit from pricing. We still anticipate strong cost savings in those numbers. Commodities, however, are still high. We still have not full anniversaried those and we're still seeing some pressure there, and we would not anticipate that we will fully anniversary our commodity cost peaks until Q3. We'll also have a little bit more higher competitive spending, and Larry has alluded to that, and we're also going to be supporting some new products. So we are expecting some modest gross margin expansion. We think we've finally seen an inflection point on our margins. In the first quarter, it's the first time in seven quarters we had margin expansion. So we're looking for that to continue.

In terms of your question on resin, certainly when we were on the last, I believe we were talking about some announced price increases and whether those might stick. What we have seen recently is that we have seen a little bit of softening in those rates. Certainly, we have seen a built-in in supply. I think the pricing in the resin market has led to some demanded destruction. I think there is also some build in inventories in resin in anticipation of another bad hurricane season, and then we've also seen some softening in housing. So all of that has led to a buildup in resin supply and a lowering of the operating rates for the resin manufacturers from probably the mid- to high-90%, probably in the lower below 90%. So we are seeing some softness there and we have reflected that in our outlook. But I will say that for the second quarter is resin is still going to be up for us in the second quarter versus a year ago, because we have not hit the -- or anniversaried the higher prices from a year ago.

And then just on that second quarter guidance, coming in toward the lower end toward the $0.48, if the sales are up 3 and with the gross margin improvement, it seems like a pretty substantial increase in advertising and promotion needed, even accounting for the $0.04 of IT charges. What type of increase should we look for on the advertising and promotional line behind the trash bags and the introductions?

And you think about it, the response that we have with the competitive activity, some of that will also be through merchandising and things like that. So some of that will come to the top line. I think the way to think about advertising is that, if you look at the year-ago levels, I think we were around $99 to $100 million. We're certainly going to be above that in the second quarter. And I think advertising levels are going to be closer to what you have seen us spend over the last quarter or two, and certainly that will be in our numbers. The other piece that's impacting us in the quarter is we have about $8 to $9 million of ITSM costs that are there and we still have an impact that we're also picking up from FAS 123(R) that comes through.

Thank you very much.

Kathleen Reed, Stanford Financial.

Good afternoon, can you just give us some more information on the IT services project, what you accomplished this quarter and what the incremental spending is for and if you've disclosed what the estimated savings are, even if they're long-term, just some more information on the whole project?

Let me step back a little bit and talk a little bit about the project. We have been working on this project now for I think the better part of a year, looking to determine what our appropriate sourcing model should be for IT services. And as we announced a few weeks ago, we have entered into a seven-year agreement with a third party to provide some of our IT services. And really what we -- this is a difficult decision to take because of the impact it does have on our employees. But we really did decide to source some of these services differently because we believe this partner can provide us with additional expertise and flexibility and capacity and scale to our IT services that will allow us to -- really will enable our growth and innovation for our businesses. So I think the technical requirements that we're seeing are becoming more complex. Upgrades to existing systems are harder to do, and really the IT needs of our businesses are growing. And that's really the reason behind the decision to source externally some of these services.

In the first quarter, most of the work around this was doing the due diligence and negotiating the services agreement, which we did, and we spent roughly about $3 million pre-tax in doing that. Originally, we had anticipated a more narrow range of services that would be outsourced, but as we got into it and we analyzed it further, we decided to do a broader outsourcing, which includes more of our -- what we will call the data infrastructure central processing. So at this point, the services that we'll be obtaining from the third-party will be our application, development and maintenance, support of the central computing environment, as well as end user support. We will still have system architecture, strategy governance and service quality and management. So that gives you a sense of the size of the project.

The total value of the agreement is estimated to be about $260 million over the seven years of the contract.

In terms of the costs that we're incurring, as I said before, most of those will be in the second and third quarter. We will have a little bit of transition cost continuing in '08. Our estimate right now on the payback on this project is about three years. So it will pay out fairly quickly. And we have not given an estimate yet when we hit the going rate on savings and we're still working out all the final details there. But the payback is in about three years and this will provide a fairly substantial cost savings for us over time, as well as the access to new technology and really being able to stay current to support our businesses.

Great. And just quickly going back to the gross margin, I think on your June call, you had expected gross margin to be down in the September quarter, and I just wondered what piece -- was it the savings piece or the lower raw materials, or what piece came in better than you had thought for your September quarter?

It wasn't really any one item we would point you to, it's just a little bit better generally across the board. When you look at the pricing benefit, it was a little bit better, cost savings were a little bit better, commodities were about on point with what we anticipated. And then logistics, other areas, contributed -- certainly trade spending efficiencies were part of it. We also saw just a little bit of mix favorability. So it was really across the board that added up to the improvement that we saw. There really wasn't any one area we would point to as being a major, major driver of it.

Finally, if volumes were down 1% in the quarter and your sales were up 5, can you just break out the top line growth between price mix and currency?

Yes. Currencies were insignificant to us in the quarter. There are really two primary drivers, with pricing representing about 500 basis points and then trade spending efficiencies roughly 100 basis points.

Okay, great. Thanks so much.

Bill Schmitz, Deutsche Bank.

Don, just to start off, do you envision any additions to the management team, any places where you think you need to add some new management members?

Right now, what I would say Bill is I'm certainly committed to working with the executive and management team that is here. So right now, I don't anticipate any changes right now.

Okay, great. And the Cannondale survey just came out and you guys made some pretty good progress the last couple of years, and it seems like this year, you kind of fell off the mat. Do you think that was related to price increases or maybe some retailer pushback, or how would you explain that change?

I don't know that we had the time to analyze all of the data, but I think we were at number 12, coming down from number 7. So we're still pretty high up in the rankings. I'm fairly certain that our pricing actions probably affected our relationship to some extent, as well as maybe lack of some significant game changers like we had in the past. But I think we still are going to feel very good about our overall ratings. Obviously, we want to work to get back up in the top 10, and we will give you I think a more detailed response as we get into the detail of the data.

One quick follow-up. Wal-Mart keeps talking about the sustainability initiative and how they want you to take 5% of packaging out of the system. Do you have anything planned for that? Are your top of it? How does that change the dynamics of that relationship?

We think sustainability is an important initiative for Wal-Mart, even beyond Wal-Mart. Obviously, we've worked on reducing the cost in our packaging, reducing the content of our plastic, using recycled material in our packaging over time and we want to continue to pursue that. In some cases, we'll do that in partnership with Wal-Mart and other customers. So it's a bandwagon that we want to get on. We see it as a good thing to do for our communities and a good thing to do for our business.

Just to add onto what Larry said Bill, I think that I mentioned early on, there were three global trends that we saw that our brands are really trying to focus on -- health and wellness, convenience and sustainability was the third. Clearly we're working closely with Wal-Mart and other customers as Larry noted to do as much as we can in this area. It's not just being on the right side of the angels, which we think it is from an environmental standpoint and our community standpoint, but we honestly think there's profit to be had in doing it the right way.

Great, thank you very much.

Amy Chasen, Goldman, Sachs & Co.

I'm just curious about the guidance. It looks to me like if you're going to come in at the low end on the second quarter, and given the third quarter guidance, it kind of implies that your fourth quarter is going to be higher, at least from what I had originally anticipated and potentially up well over 30%. Can you comment on what's driving that?

Amy I think there's a number of things that are happening in the back half. First, obviously, we're expecting a return to volume growth as we anniversary all of the last big pricing actions. And as you know, some of those came in the third quarter and the year-ago period. We're obviously coming against, while still high, we're comping against higher levels of commodities cost in the year-ago period. We also have some new products teed up for the second half of the year, a number of core growth initiatives that will be there. Cost savings will continue to contribute to our improvement as we go into the second half. And I think, as you look at it, it is more back-half loaded, but it's pretty similar to the pattern that we had last year as well because we also have seasonality there. So we are feeling pretty good about the third and the fourth quarters in terms of our performance.

Okay, thank you.

Alice Longley, Buckingham Research.

Back to the trash bags, could to quantify the gap in pricing between you and private labels, if you can put all the major chains together and come up with the norm and the gap between you and Hefty, and then tell us where that gap has become now, if you factor in all of the dealing price changes?

I don't know if I can get into that much detail on the call here. I would tell you, it's highly variable by market. Again, a lot of this pricing activity driven by merchandising activity and the private labels obviously have different pricing by customer and Hefty tends to operate quite differently by customer. But we are seeing an increasing gap, at least on a temporary basis. You recall that Hefty did basically match our pricing over the last couple of years, so we were about even. I think we would describe the gap today at about maybe $0.25 to $0.33 on key SKUs, and it's going up from there.

On which size -- $0.25 to $0.33 (MULTIPLE SPEAKERS).

I would say on our key SKUs, we had a gap of about $0.25 to $0.33, and it's going up from there.

Would the widening in the gap be like 5%? Would that be a good guess?

Actually, the $0.25 to $0.35 that Larry talked about is the widening of the gap, so actually the base gap is at a certain level and what we have seen is an incremental $0.25 to $0.35 widening of that gap.

Okay. I can back that out. And then could you give us a little bit more data on the cat litter market? How fast is that growing, and therefore, what's happening with your share?

I think I said earlier that we feel great about the new scoopable cat litter with activated carbon. We're seeing some dramatic growth on that particular part of the business. So, 25%-plus kind of growth in the quarter. That has impacted our overall cat litter business by about 5 points, so we've seen about a 5% increase in shipments in the quarter behind that launch. So we're incredibly encouraged by that product and the success of that product, and it truly is a better performing cat litter.

So your litter shipments overall in [value] terms are up 5%?

That's in volume terms.

Wasn't there pricing too?

That improvement was accompanied by a price increase of about 5%, which I think was subsequently matched by the key competitor a couple of months after that.

I'm still confused. So cat litter shipments were up 5% in volume or 5% in dollar terms or --?

Overall cat litter shipments were up 5% in volume.

In volume, and dollar sales were stronger.

So maybe up 10%

We don't give the specifics on sales by business unit in terms of a percentage growth, but it was a very strong quarter and higher than the 5% volume growth.

Do you have anything on the category itself, all retailers in?

The category in the most recent period (indiscernible) over the last quarter was up around 8 to 9%. It was [in the track channel side]. Again, that was aided by pricing which was taken both by us and competition. I think underlying this is the fact that the cat litter category for a number of reasons remains one of our stronger categories from a growth standpoint, not only now, but over time. And, again, we're in the midst of a lot of very significant innovation. So I would say just overall, the takeaway should be (indiscernible) very healthy category.

And if you added on track channels, do you think the category would be growing faster?

Probably consistent.

All right, thank you.

Linda Bolton Weiser, Oppenheimer.

Just a question for Don. I was wondering if you could comment on your impression so far of Clorox's innovation process. It's a very well-defined process, and yet there's been mixed results on the game changers recently. Maybe you could just comment, because clearly, you feel confident enough to commit to game changer for FY '08, so I'm just wondering what your thoughts are.

Let me step back just a little bit and just say from a general impression of the capabilities here and looking at core processes, not just in terms of developing products, but building brands and building business with customers and ensuring supply -- for example, those four -- I have been extremely impressed with the processes and how robust they are. To me, they mimic processes at much larger companies that I've been with. So I think the capabilities are very strong.

On the innovation front in particular, I think one of the things that we'll continue to do is stay disciplined against the process, but also from an inside standpoint, one of the things we're doing right now is starting to get our retail customers involved even earlier in the innovation process. So I would describe it as not just reacting to what we have in the pipeline, but helping us formulate insights to guide the pipeline. And so I think as we move forward, we'll see even more robust innovation coming forward. But that is clearly something the we're clearly focused on and it's probably one of the top three priorities that I have.

Okay, that is helpful. And do you have any early thoughts on international and whether there is an opportunity there for expansion, or do you think Clorox is well positioned the way it is?

Well, I think there certainly are opportunities. The way I describe the business case for this is very simple arithmetic. We have 5% of the world's population living in North America and 95% living out there somewhere else. So I think when you look at trying to accelerate growth for any company, you look at the international opportunities that are out there. As I think many of you know, we have about 14 countries that we describe as Tier 1 countries with a fully developed infrastructure, primarily in Latin America, Australia and New Zealand. There's another group of countries which we call Tier 2 where we're trying to build the brands. And I think as I mentioned, we're going through a strategy refresh project over the next 150 to 180 days, and clearly international will be one of the focus areas in that process to see where we go from here. But clearly, the business case is fairly compelling.

Do you think you will seek more partnerships?

That certainly could be an avenue or a strategy that we put in play. I think we'll better answer that question when we get a few months down the road. But, clearly, partnerships are something we're going to take a hard look at through the strategy refresh project.

Okay, thanks very much.

Joe Altobello, CIBC World Markets.

First a quick question on the commodity cost and pricing front. You noted earlier that if you did see a pull-back in commodity cost, you would probably reinvest a good portion of that. Is that your call, or are you being encouraged or you could be encouraged by retailers to spend on the trade of commodity costs that come back?

Joe, we were very careful when we went out with our pricing actions to talk about the fact that we are pricing to the spikes in commodities, but we're pricing to what we think the long-term average is. So our customers have been very reasonable about this. We have not had a lot of pushback to that about rolling back prices. So most of the activity we're talking about is in response to competition, particularly in the trash category, not customer-driven.

Secondly on resin, you the inventories were up. Is there any talk about additional capacity coming online in calendar '07?

The capacity we see coming online is likely to be in '08 and beyond and it's Middle East and Asia capacity that's coming on. What that should certainly do at that point in time is start to satisfy some of the growing international demand. And so you're likely to see probably less export of resin then out of the U.S., and certainly that will help the pricing picture.

And then lastly, you mentioned that your share was up in four out of eight track categories. I imagine the four that were down were Laundry, Auto, Brita and Glad.

Glad was down -- I think you had it right. Glad was down, Cat Litter was up, Food was down, Charcoal was up, Laundry down, Homecare down slightly, Brita up and Auto Care up.

Okay, great. Thanks.

Alec Patterson, RCM.

Just one other line item on the gross margin breakdown, Dan, if you have it. In the past, you've talked about how fuel and logistics and all that have played through. Was that much of a factor in the quarter?

You know, embedded in the commodity cost increases and some of logistics impacts, obviously, is the energy component. And it played out about as we anticipated for the quarter. So there was really nothing there that was out of what we had already factored into our outlook.

I'm sorry -- are you saying that the logistics element is part of the 280?

No, it's part of the all other 50 I talked about. So the 280 is -- obviously, we have the energy component in there and resin and core alkali, and then we also have logistics, which I included in the 50 basis points I talked about. So certainly, we're still seeing a period-over-period impact in those costs.

Okay. And then just sort of taking what seems to be the trend you're outlining here on the margin structure, gross margin is the driver, the SG&A seemingly may uptick as gross margin deviates from plan. But as a driver to your EBIT margin and then flowing down the net margin, all things being equal, could you speak to what you see on your free cash flow to sales trend? Because it looks like you're working on your working capital, and the CapEx, I haven't had heard any changes as a percentage sales. So is that expected to rise here for some more debt reduction? Can you give sort of an outlook on that?

Yes, for the quarter, our free cash flow was about 9% of sales. And I think we remain very disciplined on CapEx, capital spending -- target 4% or less of sales. I think our current outlook is that it would be probably a bit below the 4% level for the full year. What we have spent over the last year or two is roughly about equal to our depreciation and amortization. And I think that is probably a good estimate for the balance of this year.

Overall, on free cash flow, we are in a range of 10 to 12% of sales -- that's generally the pace that we're on. In terms of debt paydown, we have applied a lot of our free cash flow to reduce debt levels. We do anticipate that we'll hit our debt to EBITDA target of 2.0 to 1 later in fiscal '07. So we are on track to pay down debt to get to that target level. And then obviously, we will have the freedom of how to use that free cash flow at that point.

Dan, let me ask the question a different way, then, because I didn't get the answer I was looking for. Is working capital expected to change much as a percent of sales this year from prior trends?

No, you should cede consistent trends, Alec, on there. We are very good in receivables. We had a little bit of improvement this year in inventory. Inventory, I think, will hold for the full year. So on working capital, you should not expect any significant changes in that over the course of the year.

Put, again, the other way, net margin should flow to free cash flow margin?

Yes, I think that's a fair way to think about it.

Okay, thanks.

Connie Maneaty, Prudential.

Can you give us an update on the progress of Anywhere Hard Surface and how it's being accepted now as you repositioned it?.

Anywhere we thought would be a game changer. We feel good about the progress today. It's a solid product. Typically, it's in the top 25% of SKUs in the Homecare category. It's not as big as we had hoped it was. It clearly is -- maybe more of a paradigm shift and a change in behavior than we anticipated. And so we have been experimenting with some new approaches in terms of advertising and other marketing vehicles to try and communicate it more clearly. So we have a few small tests going on. We are supporting the brand on a broad-scale basis. It's a solid item in our line, but just not as big as we had hoped it was going to be.

I think just to add on to what Larry said, one thing I would say is the consumers who have tried it seem to really love it. And as Larry said, this is kind of a paradigm shift in education educating people on what this product is and what it can do. It has obviously proven a little bit more difficult than we thought, but the people who use it love it. And consequently, I think that customers are still positive about it.

So is it being nationally advertised, or you are testing advertising in different markets right now?

It's both. We have pulled back on our national advertising support, but it's still being supported on a national basis, and then we have some specific tests going on in some select markets.

Okay, if I could also follow-up with a question on IT. Did I miss it, or are you not telling us who your IT partner is?

We said that in the 8-K. It's Hewlett-Packard.

Okay. And how many of your employees are affected? Are they going over to HP in this transition, or will there be charges for severance? And have those charges -- are they included in the extra $0.04 or $0.05 -- I guess that is the question?

All of the people-related costs are in the $20 to $22 million figure that I gave you. In terms of the people, there is to about 100 to 120 positions roughly for people who will continue to work for Clorox. We anticipate about 25 to 30 people will go over and become employees at Hewlett-Packard. And then, there's about 200 people, 200 employees, whose positions will be eliminated beginning in January 2007. And the timing for the elimination of those jobs stretches over time based on the transition plan that we have with HP.

Okay, that's very helpful.

John Faucher, JP Morgan.

Don, good to talk to you again. Sort of a philosophical question about advertising. You talk about sort of upping the spending levels. You guys are still pretty close to your peak level, so is this something -- where we say, okay, we need to get back to the peak levels? Or is it just temporary? Does it have to do with the negative volumes, or maybe some of the issues you talked about on the new products? Can you just give us sort of more of a philosophical view of the ad spend line?

Philosophically, advertising drives our business, and we absolutely believe in building our brands over time. We have lots of good data in terms of impact of advertising and other components of our marketing plan, including things like public relations. We would love to spend more on the advertising front and it does kind of go up and down by quarter a little bit, depending on new product launches, competitive activity, success of particular campaigns we may have. But we have been around that 10% range. And I don't know that small differences in any quarter are really dramatic departures from that kind of philosophy of -- we fundamentally believe in the brand-building impact of brand advertising, short-term and long-term.

Okay, so as you look at the recent volume results, you are not sitting there saying, okay, we need to up the levels. You think it's due to the pricing; the elasticities or where they are, and so we shouldn't see any real change in your philosophy surrounding advertising or a need to really ramp up the spending level?

I wouldn't describe this as a scope change in terms of our approach to advertising. Again, we would love to spend more, but we think that range that we have been is probably about right on a long-term basis. And so I think what you're saying in the second quarter would be a [strive] as a pickup at this point in time to address other situations and not a change in philosophy or a scope change in terms of how we think about our spending.

And the only thing I would add, John, to what Larry said is I think that -- not just a question of spending levels, which I think he articulated well. It's also the overall effectiveness of the copy, which I think the brand teams are really focused on even getting stronger on the effectiveness of the copy. I think there has been very good copy developed here over the last couple of years.

Having said that, we all know we can do better. We keep pushing the envelope on making the copy as effective as possible. The other thing as we all know, the 30-second commercial isn't what it used to be. As we look at our media plans and how we spend that money against advertising, I think we are looking at how we transform our communication programs with consumers. It's not just about television advertising anymore, or print.

Lauren Lieberman, Lehman Brothers.

Just a first quick question on international. What was the business that you exited in Australia? And if we took that out, what would volume growth have looked like for international?

The business in Australia was a tabletop business, I believe, in our glass business. So it was a low-margin line that we decided to discontinue. And I don't have in front of me what volume would have been as form that. It did have an impact on us, but I don't know how material it really was.

Okay -- Clorox Anywhere -- since you mentioned you're still in testing, we shouldn't think about the branding relaunch in the second quarter. That is still probably a second-half initiative?

I think that would be accurate.

Okay, great. And then just a final thing within Wal-Mart -- we all know they've talked about some pretty aggressive plans for rollbacks -- ongoing inventory management. Anything we should kind of be watching out for there or indication you have that any of your brands are going to be some of those featured on or rollback?

I would say -- this is -- for the Wal-Mart business for the Wal-Mart is status quo. They are obviously a big, important customer for us. We have a great partnership. Their growth rate over the last quarter was much higher than the remaining customer base, which has been typical of the last several years. So we're going to keep going.

Okay. And anything that you know yet about their plans with the All brand of bleach? Have you seen that -- any change in the shelf space allocated to All?

You know, I could speak to their plans on All. I think that you can observe and we can observe that the amount of shelf space devoted to All has been pretty minimal over the last several months, and our merchant activity has diminished considerably. And our hope would be that would go away. But we have no insight into their plans.

This would conclude our question-and-answer session. Mr. Knauss, I would like to turn the call back to you at this time.

Well, we certainly appreciate you folks joining us. And we look forward to subsequent quarterly calls, and certainly, the May 24 meeting with all of you in New York. So thank you for being with us today, and we appreciate your time.

Thank you, everyone, for your participation. You may disconnect at this time.